Government Regulation and Intervention Part 1

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Government Regulation and InterventionPart 1

• Vivian Ho
• Health Economics

This material draws heavily from Santerre Neun
Health Economics, Theories Insights and Industry
Studies, Southwestern Cengate 2010
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Introduction

• Causes and consequences of government
  intervention in health care.
• Types of government intervention.
• Case studies
• Cigarette taxes.
• Price ceilings on health care services.
• Hospital antitrust litigation.

3
Criteria for perfect competition

• All firms and consumers are price takers.
• Consumers and firms have perfect information.
• All firms produce an identical product.
• Firms can freely enter an exit an industry.

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Market imperfections may lead to inefficient or
inequitable distribution of resources.

• Imperfect consumer information
• Monopoly
• Externalities
• Government intervenes to restore efficiency
  and/or equity.
• Public interest theory.

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An opposing theory The amount and types of
government intervention are determined by supply
and demand.

• Vote-maximizing politicians supply legislation.
• Wealth maximizing special interest groups are the
  buyers.
• Successful politicians stay in office by
  satisfying special interest groups.

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Special interest group theoryExamples

• Extended patent protection for brand name drugs.
• Rejection of national health insurance in favor
  of private insurance companies.

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Special interest group theory claims that special
interest groups gain at the expense of the
general public.

• Consumers are diverse, fragmented, more costly
  for them to organize.
• Inefficient, inequitable resource allocation by
  government.
• Which theory do you believe?
• C-B analysis is needed to identify winners and
  losers.

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Types of Government Intervention

• Provide public goods.
• Correct for externalities
• Impose regulations.
• Enforce antitrust laws.
• Sponsor redistribution programs.
• Operate public enterprises.

• Fund medical research.
• Tax cigarettes, pollution.
• FDA
• Bar hospital mergers.
• Medicare and Medicaid.
• VA hospitals

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Public Goods

• gt1 individual simultaneously receives benefits
  from the good.
• i.e., no rivalry in consumption.
• Costly to exclude nonpayers from consumption of
  the good.
• Private firms unwilling to produce and sell
  public goods.
• Are most medical services public goods?

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Externalities

• Definition An unpriced byproduct of production
  or consumption that adversely affects another
  party not directly involved in the market
  transaction.
• Cigarette smoking
• Pollution
• Medical treatment for cyclists who dont wear
  helmets
• Drunk drivers

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• Demand-side externality
• Marginal Social Benefit ? Marginal Private
  Benefit
• Supply-side externality
• Marginal Social Cost ? Marginal Private Cost

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Cigarette smoking is an example of a (negative)
demand-side externality.

• Smokers impose work-related costs on nonsmokers.
• Health insurance, pensions, sick leave,
  disability, group life insurance financed
  collectively by smokers and nonsmokers.
• But smokers, die earlier, pay less taxes,
  premiums.

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Smokers also impose health care costs on
nonsmokers.

• Smokers usually incur higher health care costs.
• But nonsmokers die prematurely from passive
  smoking, smoking-related fires.
• The total external costs of cigarette smoking are
  estimated to be 15 per pack.
  (Manning et al., 1991)

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Keep in mind

• The problem which calls for government
  intervention is external costs, not internal
  costs.
• The full extent of external costs must be
  measured using a lifetime approach.

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Manning et al.s methods

• Numerator takes into account life expectancy for
  smokers and the costs (savings due to early
  death) incurred each year.

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External Cost Components

• Covered medical costs.
• Covered work loss and disability.
• Group life insurance.
• Widows social security bonus.
• Covered nursing home costs.
• Pensions.
• Taxes on earnings.
• Fires.

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per pack
SMPCMSC
MSC0
DMPB
MSB0
MSB
Q0
Q1
Cigarette Packs

• At Q0 MSC0 gt MSB0
• Cigarettes are being over-consumed.

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Government can use taxes and subsidies to alter
economic incentives, correct for externalities.

• Charge a tax on cigarettes that reduces
  consumption to the socially optimal level Q1.
• Levy a per-unit tax T on cigarette makers equal
  to vertical distance between MPB and MSB at Q1.

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per pack
MPC0 T
MPC0MSC
P1
P0
P2
DMPB
MSB
Cigarette packs
Q1
Q0
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With tax

• Market price of cigarettes P1
• Cigarette manufacturers receive P2 per pack.
• Tax burden
• Consumer pays P1 - P0
• Seller pays P0 - P2

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The relative tax burden on consumers vs.
producers depends on price elasticities for
supply and demand.

• If demand for cigarettes is inelastic, consumers
  bear a larger?/smaller? Share of the tax burden.

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Further issues

• The current tax per pack exceeds external costs.
  Is this OK?
• Should smokers or cigarette companies be
  responsible for the external costs of smoking?
• Thank you for smoking. Is this moral??

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Regulations

• Government can attempt to control price,
  quantity, or quality of health care products.
• Example Price Ceilings in The Canadian Health
  Care System.
• Consumers are fully insured by the government.
• The government fixes the price the physician
  receives for each visit.

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Regulations

• Because consumers are fully insured, they will
  demand the number of visits as if the price per
  visit 0.
• Assume that the government sets a reimbursement
  rate for physician visits equal to PC.

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Price
S
PC
D
QD
QS
Physician visits
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• With full insurance, consumers want QD visits.
• But the government has fixed the price of visits
  at PC.
• Only QS visits will be provided.
• Shortage of physician visits QD - QS.

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Consequences

• 1)Physicians may treat patients on 1st-come,
  1st-served basis, regardless of severity/urgency.
• 2)Patients will have to queue for care/not
  receive care.
• 3)Unethical doctors may take bribes from patients
  trying to jump the queue.

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Lesson There is no free lunch under cost
containment. Price ceilings can lead to

• 1) Shortages.
• 2) Longer waiting lines.
• 3) Nonprice rationing.
• 4) Poorer health outcomes.

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Antitrust Sherman Antitrust Act

• Section 1
• Every contract, combination in the form of
  trust or otherwise, or conspiracy, in restraint
  of trade or commerce among the several states or
  with foreign nations, is hereby declared illegal.

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• Section 2
• Every person who shall monopolize, or conspire
  with any other person or persons to monopolize
  any part of the trade or commerce among the
  several states, or with foreign nations, shall be
  guilty of a misdemeanor.

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The Act prohibits anticompetitive business
practices that promote inefficiency and inequity
in the marketplace, such as

• Price fixing - when business rivals enter a
  collusive agreement to refrain from price
  competition fix the price of a good or service.
• Hospitals in a given city cannot jointly
  establish the price of various hospital services.

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• Boycott - agreement among competitors not to deal
  with a supplier or a customer.
• Physicians in an area cant collectively agree to
  deny services to a particular managed care
  organization.
• Market allocation - when competitors agree to
  compete with one another in specific market area.
• Hospitals in the same city cant collectively set
  geographic service boundaries.

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• Price fixing, boycotting, and market allocations
  are illegal per se.
• The plaintiff must only prove these actions took
  place for the defendant to be in violation of the
  Act.
• In contrast, rule of reason doctrine is used to
  evaluate horizontal mergers under the Act.
• While horizontal mergers may force price above
  the competitive level, they may also create
  benefits which could be passed on to the customer.

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Redistribution

• The government often taxes one group and uses the
  revenues to subsidize another. Why?
• Interdependent utility functions.
• Donors get utility from increasing the welfare of
  recipients.
• Why is the government involved?
• free rider problem.

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Two notions of equity in redistribution programs

• Vertical equity
• Unequals should be treated unequally.
• People who earn more should pay higher taxes.
• Horizontal equity
• Equals should be treated equally.
• Two persons with the same income level should pay
  the same in net taxes.

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Vertical equity in practice

• How much more in taxes should higher income
  people pay?
• Suppose high income households pay 4,000 in
  taxes on average, and low income households pay
  2,000. Is this equitable?

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• If the high income household makes 100,000, they
  pay a 4 tax.
• If the low income household makes 10,000, they
  pay a 20 tax.
• The notion of equity in taxation depends not just
  on total tax revenues, but on income levels and
  tax rates as well.

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• In practice, vertical equity is achieved when the
  net tax system is sufficiently progressive.
• Taxes as a fraction of income rise with income.
• Federal income tax system.

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Other forms of redistribution

• Proportional.
• The fraction of income going to taxes is constant
  as income rises.
• The Medicare tax is a fixed of payroll income.
• Regressive.
• The fraction of income going to taxes falls as
  income rises.
• Sales tax

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Implementing redistribution

• Supply-side subsidies
• Government funding aimed at reducing the costs of
  producing a consumer good or service.
• Subsidy to a public hospital.
• Tuition for nurses or doctors.
• Potentially violates notion of vertical equity
• if all persons have equal access to the
  subsidized product.

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• Demand-side subsidies - government funding for
  consumers.
• In-kind vouchers or reimbursements for specific
  services.
• Food stamps, Medicare, Medicaid
• Cash government-provided income that people can
  use at their own discretion.
• AFDC, Supplemental Security Income
• Keep in mind It is difficult to guarantee
  horizontal equity with multiple programs in
  operation.

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• Consumer Groups Accuse U.S. of Negligence on Food
  Safety
• The New York Times, October 15, 2002

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Back to the Start

• Does government intervention correct for market
  imperfections, or is it ruled by special interest
  groups?

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A Final Caveat

• Market failure is a necessary, but not sufficient
  condition for government intervention.
• It may cost the government 10m to correct a
  problem in the marketplace, which imposes 8m in
  damages.
• While markets may fail and impose societal costs,
  the costs of government intervention may be
  greater.